Crude oil’s recent break below the $78 per barrel level could foreshadow lower oil prices, but the real reason I’m bearish on black gold is the U.S. dollar.

The dollar has taken a beating[1], yet crude was not able to mount a rally on the most recent dollar weakness. That should be a red flag for investors.

Oil is typically hypersensitive to movements in the U.S. dollar. If you look at the oil stocks — both the producers and the oil-service players — they are currently on a “sell” and are going lower.

This points to two probable scenarios: Either the smart money thinks that the U.S. dollar will rally, or (and more likely in my opinion) the global recovery won’t be as robust as advertised.

China’s Growth Engine Won’t Save Us

If you want to see the future, you need to look to China. And what we are seeing over there doesn’t bode well for the rest of us.

Much of our recovery is being driven by Asian growth. This growth story looks to be imperiled, at least over the short term.

It appears that China’s central planners are getting concerned about the pace of China’s economic growth and are taking steps to curb that growth.

The most troubling measures being considered are the rumored new banking rules that will require banks to raise their capital ratios to 13%.

This acts like an anchor on economic growth, as banks are forced to either slow the pace of their lending or else raise gigantic sums of new money.

So far, the 13% number has been denied by one of the big Chinese state banks, but that wasn’t enough to stave off a 3.5% sell-off the night of Nov. 23. The market knows that there is a good chance we will see China impose strict lending curbs just as it did back in 2007.

Emerging Markets Pullback?

We’re also seeing Brazil (another engine of growth) attempt to slow down investment in its country via the introduction of higher transaction taxes.

If the emerging market economies are consciously taking steps to slow their growth, how can this not negatively impact crude oil prices?

The Best Oil ETF to Short

It’s going to take a move above $83 to get me to cover my oil shorts and get me bullish on crude again. In the interim, it looks like a terrific short on any kind of strength.

I prefer to short crude directly in the futures market. (Learn how to trade commodity futures[2].) But if the idea of trading futures fills you with fear and dread, don’t worry!

Instead, you can use an exchange-traded fund (ETF)[3] to play oil prices. My favorite oil ETF is the PowerShares DB Oil Fund (DBO[4]).

Commodity ETFs have been having a tough time dealing with contract roll spreads (i.e., selling their front-month contracts and purchasing the next month’s contract), and that has been messing with their performance.

DBO has been doing a much better job managing its contract rolls than the more widely known U.S. Oil Fund (USO[5]), the latter of which was investigated by the Commodity Futures Trading Commission (CFTC) earlier this year for a “roll” it did back in February.

Avoiding challenges with their “rolls” is why I would suggest staying away from USO and using DBO if you’re looking for an oil ETF to play.

For now I would short DBO with put options[6], but it’s also a good ETF to go long when the time comes to be bullish on crude again.

Related Articles:

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The Best Hedge Against the Falling Dollar[8]

Stocks vs. ETFs: What’s the Better Investment?[9]

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Endnotes:

dollar has taken a beating: http://www.optionszone.com/market-commentary/market-analysis/2009/11/commodity-etfs-the-best-hedge-against-the-falling-dollar.html